In this appeal of a post-trial bench decision by the Court of Chancery, the Delaware Supreme Court affirmed the Court of Chancery’s finding that a buyer did not breach an earn-out provision in a merger agreement.

The appellant represented former stockholders of Cyveillance, Inc. (collectively, “seller”), which was acquired by Qinetiq North America Operations LLC (the “buyer”). The buyer paid $40 million up-front to the Company and promised to pay up to another $40 million if the Company’s revenues reached a certain level. Section 5.4 of the merger agreement prohibited the buyer “from tak[ing] any action to divert or defer [revenue] with the intent of reducing or limiting the earn-out payment.” When the earn-out period ended, the revenues had not reached the level required to generate an earn-out.

The seller filed suit in the Court of Chancery, arguing that the buyer breached Section 5.4 of the merger agreement. The seller also argued that the buyer violated the merger agreement`s implied covenant of good faith and fair dealing by failing to take certain actions that the seller contended would have resulted in the achievement of revenue sufficient to generate an earn-out.

After post-trial oral argument, the Court of Chancery entered judgment in favor of the buyer on both claims. On the claim for express breach, the Court found that, pursuant to the plain terms of the agreement, the seller had to show that the buyer acted with an intent to reduce or avoid the earn-out payment. On the claim for breach of the implied covenant, the seller had to show, consistent with the language of Section 5.4, that the buyer acted with intent. On both claims, the seller failed to demonstrate the necessary intent because it had not proven that any business decision of the buyer was “motivated” by a desire to avoid an earn-out payment.

On appeal, the seller argued that the Court of Chancery erred because it should have recognized that Section 5.4 used a knowledge standard, not an intent standard. According to the seller, the merger agreement prevented the buyer from taking actions if it knew those actions would reduce the likelihood that an earn-out would be due. The seller also claimed that the Court of Chancery erred when it held that the implied covenant must be read consistently with Section 5.4, because the specific standard in that contractual term reflected the parties’ agreement about how the seller would be protected from post-closing conduct that could jeopardize an earn-out payment.

The Supreme Court found that the seller`s arguments were without merit. By its unambiguous terms, Section 5.4 only limited the buyer from taking action intended to reduce or limit an earn-out payment. Intent required that the buyer be “motivated at least in part” by a desire to avoid the earn-out, which the seller did not prove.

As for the implied covenant claim, the Supreme Court thought the Court of Chancery was “very generous” in assuming the implied covenant applied at all, given the specificity of the merger agreement on decisions affecting the earn-out and the negotiating history. The seller attempted to negotiate for a range of additional affirmative post-closing obligations that were all rejected by the buyer, except the burden to not take action with the intent of reducing or undermining the earn-out payment.